- Based on information available on the site, what were the main economic problems common to Bolivia and Poland as they approached their respective crises?
Inflation or "hyperinflation" was the main symptom in both cases. In both countries there were also extreme shortages of basic goods.
The common root causes were also related: high deficit spending by the government, massive government debt, lack of economic productivity, lack of real economic growth and lack of any incentives for private investment.
(Further explanation for use in class discussion):
Both governments were spending vastly more than they could take in from taxes, tariffs, etc. The annual budget deficit was compounded in both cases by massive national debt accumulated during previous years, much of it foreign. This meant that most of the money coming in to the government was needed to pay off creditors, leaving less or none for social programs and investment in future economic development. Rather than cut expenditures and risk dangerous social unrest, both governments simply printed more and more money to make ends meet.
The expanding supply of money had to chase a finite supply of goods, however, which produced rising prices. Inflation meant that the nation's currency also began losing exchange value relative to foreign currencies. That, in turn, made its foreign debt grow even larger, putting more pressure on the budget.
To stop the erosion in currency value and quell the rising prices, both governments attempted to control their internal markets through restrictions: price controls, fixed currency exchange rates, import quotas, permits etc.. . all of which only served to distort the workings of the market and destroy incentives for private investment in production of goods and services. The evaporating value of the currency, the inability to make accurate projections about future costs and margins, the tangle of changing regulations and the burden of pervasive corruption, all added to the risk, making investment in the "legitimate" market increasingly unattractive. Instead black markets flourished outside the law -- with prices set by actual supply and demand, with a premium charged for risk.
When money weakens and there are no good opportunities for productive, lawful investment, prices rise further as people try to exchange currency for anything that will hold or increase in value as money goes down. Often a very attractive option is to buy the currency of other, more stable countries. The result is capital flight, via the black market, if necessary.
As corruption increases, capital flows out, and inflation gains, more and more activity is siphoned away from the legitimate economy and government revenues from taxes and tariffs fall further. All growth ceases, sources of investment capital dry up completely, inflation accelerates into hyperinflation, life savings evaporate, goods disappear from the shelves, and poor people become desperate to buy something -- anything that they may be able to sell a day or two later at a higher price. Long term planning becomes impossible and the social fabric threatens to disintegrate into lawless violence.
- What were the key components of "shock therapy" as applied in Bolivia and Poland, and what were reforms designed to acheive?
- End the deficit spending of governments even if that meant cutting social programs. Various ways of saying the same thing include: balance the budget, spend only as much as they receive in revenues, stop printing money to make up for budget shortfalls, etc. This was seen as the primary measure for eliminating inflationary pressures on the economy. Controlling inflation was the key measure to enable savings to retain their value, create the stability necessary to encourage profitable investment from both domestic and foreign sources.
- End price controls. By removing price controls, prices would be set by the laws of supply and demand rather than by central government agencies. When markets are functioning properly, the profit motive provides a sufficient incentive for entrepreneurs to invest and add to the supply of goods and services, which, in turn, increases competition, causing prices to fall. As prices rise and then settle to competitive market levels, government tax revenues often improve as a consequence or greater economic activity. This improves the budgetary balance as well.
- Privatization of businesses including what were considered the key national industries. Privatization and competition were seen as the best means for encouraging improvements in productivity.
- Another possible response: Seek debt relief (debt burden reduction, loan restructuring, or loan forgiveness) from creditor institutions and nations to ensure that a greater portion of government spending can go to improving the productivity of an economy, including social services, rather than simply to pay interest on debts.
